Question

In: Finance

1. The Frosty Delights Ice-cream House currently rents an ice-cream machine for $50,000 per year, including...

1. The Frosty Delights Ice-cream House currently rents an ice-cream machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead, and is comparing two options:
I. Purchase the machine it is currently renting for $150,000. This machine will require $20,000 per year in ongoing maintenance expense.
II. Purchase a more advanced machine for $250,000. This machine will require $15,000 per year in ongoing maintenance expense and lower annual packaging costs by $10,000. Additionally, the machine will require an upfront expense of $35,000 for training of operators.
Maintenance and packaging costs are paid at the end of each year, but the rent of the machine is paid at the beginning of the year. Suppose the appropriate discount rate is 7.75% per year. Assume also that the machines will be depreciated via the straight-line to zero method over seven years and that they will be used for 10 years with no salvage value at the end of use. The marginal corporate tax rate is 22%. Should the Frosty Delights Ice-cream House continue to rent, purchase its current machine, or purchase the advanced machine? (10 points)

Solutions

Expert Solution

Buying the current machine is the best option with highest NPV

NPV $54,069.46

NPV of buying new machine =

NPV $49,974.16

Workings

Buy Current machine
Year Saving in rent
post tax		 Purchase price Maintenance
after tax		 Tax shield Net CF
0 39000 -150000 -111000
1 39000 -15600 4714.29 28114.29
2 39000 -15600 4714.29 28114.29
3 39000 -15600 4714.29 28114.29
4 39000 -15600 4714.29 28114.29
5 39000 -15600 4714.29 28114.29
6 39000 -15600 4714.29 28114.29
7 39000 -15600 4714.29 28114.29
8 39000 -15600 23400.00
9 39000 -15600 23400.00
10 -15600 -15600.00
NPV $54,069.46
New Machine
Year Saving in rent
post tax		 Purchase price Maintenance-packing
after tax		 Tax shield Training cost Net CF
0 39000 -250000 -27300.00 -211000.00
1 39000 -3900 7857.14 42957.14
2 39000 -3900 7857.14 42957.14
3 39000 -3900 7857.14 42957.14
4 39000 -3900 7857.14 42957.14
5 39000 -3900 7857.14 42957.14
6 39000 -3900 7857.14 42957.14
7 39000 -3900 7857.14 42957.14
8 39000 -3900 35100.00
9 39000 -3900 35100.00
10 -3900 -3900.00
NPV $49,974.16

jeff jeffy answered 7 months ago
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